Answer to In class exercises on CAPM students0

# Answer to In class exercises on CAPM students0 - A nswer to...

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Answer to In class exercises on CAPM 1) a. The CAPM assumptions imply that the best possible risk-return combinations are combinations of the risk free security and the market portfolio- portfolios on the CML. Let us find the CAML portfolio that has an expected return of 9%, equal to the McDonald’s return. We need to determine the proportion to invest in the market so that 9%= 4%*(1-x) + 10%*x. Solving for x gives x=0.8333. Therefore you should invest \$8,333 in the market portfolio and \$1,667 in the risk free security. The volatility of this portfolio is 0.8333 * 16% =13.3% (much lower than 27%). Notice that 0.833 is also the beta of McDonald: beta is the factor loading on the market portfolio b. Alternatively we can choose the CML portfolio that matches McDonald’s volatility of 27%. To do so we need to invest a proportion x such that 27% = x * 16%. Solving for x gives x=1.6875 so the expected return is 4%*(-0.6975) + 1.6875*10% = 14.1% a much higher expected return than 9%. To form this portfolio, you need to borrow \$6,875 and

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## This note was uploaded on 04/17/2011 for the course COMM 299 taught by Professor Desrochers during the Spring '08 term at UBC.

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Answer to In class exercises on CAPM students0 - A nswer to...

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